Tangoe: Dancing on an Old Grave, Digging a New Hole?

by Melissa Davis and Sonya Colberg - 8/28/2012 2:12:04 PM

Talk about tricky moves. As a young public company with a taintedleadership team and an expensiveshoppinghabit, Tangoe (Nasdaq: TNGO) could have easily tripped over tough questions alone by now. So far, however, Tangoe has spent more than a full year successfully dancing around a maze of potential landmines.

Currently in the midst of a muscular growth spurt, Tangoe has spent the past two years gobbling up smaller players that resemble itself in order to further bulk up its own share of that tasty market. That feast has cost a fortune, however, with growth-hungry investors footing much of the tab along the way.

Because of that expensive (and often risky) growth strategy, Tangoe looks an awful lot like the so-called “rollup” companies that have by now given investors plenty of reason for alarm.

As the last acquisition-driven company examined by TheStreetSweeper has already proven, those highfliers can sometimes crash in spectacular fashion. Just look at Swisher Hygiene (Nasdaq: SWSH) for some timely evidence. The stock chart for that rollup company tells a horror story (briefly summarized later) all by itself.

Tangoe looks more like a fairy tale at this point itself. Applauded from the start, when it debuted as a bleeding company with a decade of losses, Tangoe rapidly doubled in price months before reaching its first anniversary on the Nasdaq exchange. The stock went on to peak above $23 a share and continues to hover near the high end of that range, recordsshow, even after a dilutive secondary offering and the recent expiration of a lockup period that could still flood the market with a river of shares.

In other words, at current levels, Tangoe arguably reflects few (if any) of the serious risks that could threaten its generous stock price. By rewarding Tangoe with such a lofty valuation, the remainder of this report would suggest, the market has overlooked all or most of the following:

An expensive shopping spree, financed by the proceeds from stock offerings, that has resulted in explosive growth so far but – with remaining buyout targets (and the excess cash to cover them) now limited – could soon come to an end

A perfect track record for delivering that upside, which further intensifies the pressure on management to please Wall Street by extending its winning streak

TheStreetSweeper has researched Tangoe extensively this summer, reviewing many of these disturbing topics in detail, and packaged its findings in a comprehensive two-part investigative report. As the first installment in that Tangoe series, this story examines both the dark history of its leaders and the recent drivers of its celebrated growth; the remaining article, set to follow soon, will further expand on issues highlighted in this story and cover new ground as well.

TheStreetSweeper contacted Tangoe through its public relations firm, seeking input for this report, but received no response from the company.

While management had originally predicted that a recent acquisition would add only $500,000 to its first-quarter sales, recordsshow, Tangoe actually wound up booking $800,000 in revenue from that acquisition instead. When specifically asked about potential differences between the projected and actual contributions provided by the new companies that it had just purchased, however, Tangoe stuck by its original numbers – portraying its old guidance as “in line” – despite the outsized boost that it had received as a result of that especially helpful deal

Tangoe recorded a 40% jump in sales generated by that overlooked division in the first quarter, a stark difference from the meager single-digit gains that it had realized over the course of the previous three years. For some reason, its filingssuggest, Tangoe spontaneously fielded an extra $800,000 worth of orders for its older services – with half of that generated by lucrative software licensing fees – long after the company had given up on actively pursuing that business itself. Without that helpful burst in demand, recordsindicate, Tangoe would have strained to simply meet (let alone beat) profit forecasts for the first quarter and ruined its perfect record for outperformance by now.

Because software license fees often carry gigantic margins (of 80% and beyond), most of those sales drop straight to the bottom line. By recording a $400,000 increase in those valuable fees during the first quarter (with a similar boost in other noncore services further adding to that help), recordsindicate, Tangoe wound up with a convenient surplus that it really seemed to need.

Outraged shareholders later responded by filing a class-action lawsuit against IMA and its top executives, naming Subbloie and Martino as the only individual defendants and therefore holding them personally responsible for the fiasco.

“Defendants engaged in a common course of conduct that operated as a fraud on the integrity of the market for IMA common stock by intentionally or recklessly issuing quarterly financial statements which materially overstated the company’s actual revenues and assets and materially understated its expenses and net loss,” that lawsuit proclaimed. Indeed, “25% of the revenue originally reported did not exist …

“These manipulations created the appearance that IMA’s financial condition was improving drastically from a year earlier,” the lawsuit added, “when in fact IMA’S financial condition was rapidly deteriorating” instead.

Dangerously low on cash, the complaint stated, IMA fabricated half of its quarterly revenue from licensing fees – booking millions that it could not reasonably expect to collect – and wound up securing the funds that the company desperately needed in order to survive. As the CFO responsible for compiling those numbers, records show, Martino wasted no time basking in the glory of the applause that erupted on that report. The very day that IMA loudly trumpeted its newfound “success,” the company also casually noted that Martino had decided to step down as its longtime finance chief and oversee a new subsidiary instead. While Martino retained his secondary role as chairman of the board, he quickly distanced himself from the executive suite – and the finance office in particular – ahead of the disaster that would soon begin to unfold.

After first quietly joining the board of the company that would soon become Tangoe itself, recordsindicate, Subbloie and Martino steadily clipped all formal ties linking them to their original failure. When they carried out their first big move by resigning from their leadership positions at IMA (as CEO and chairman respectively), a local news report shows, the Nasdaq promptly responded by halting the battered stock. When they followed up with their second (and final) step by vacating their regular boardroom seats a few months later, the press release announcing that development included no stock symbol at all.

While the disgraced leaders volunteered to serve as “consultants” for another 90 days at that point, IMA soon ran out of time and spared them the leftover hassle. Two weeks later, recordsindicate, the company – its stock already halted, its resources now drained – filed for Chapter 11 bankruptcy protection and then faded into oblivion.

Following an interview with Subbloie earlier this year, for example, a local business newspaper simply mentioned that IMA had filed for bankruptcy after “the Internet bubble burst” in a glowing article that basically painted its former leader – and his new company – as a proven success.

For starters, its filingscontinueto suggest, Tangoe has yet to even implement standard internal controls over its financial reporting process. Furthermore, recordsshow, Tangoe has placed a tarnished auditing firm – with a record of outright “audit failures” – in charge of catching any misstatements that the company, without its own safeguards, might have included in its books.

When IMA selected its own auditors, court records show, the company actually chose two different top-name firms that (at the time) ranked among the most respected in the country. Of course, those same records indicate, IMA also terminated both of those auditors after they took exception with its accounting practices upon a thorough review of its books.

Tangoe did hire one of those big-name firms for a consulting project, its filings show, with PricewaterhouseCoopers reviewing its compensation policies and recommending bigger payouts for its top executives. But Tangoe stopped short of splurging on that respected firm as its actual auditor for some reason, records show, even though its business model heightens the complexity of its financial reports.

Despite the moderate image that its leaders like to present, Tangoe bears an obvious resemblance to traditional rollup companies with inherently risky business strategies. Leaning heavily on acquisitions to supplement its organic growth, recordsshow, Tangoe regularly buys up smaller companies and then books their revenues as its very own. While perfectly legal and even formerly popular, that strategy has also proven notoriously susceptible to accounting tricks and other hidden dangers that can result in some rather tragic consequences for investors.

Take Swisher as a convenient example. A popular growth stock with massive gains itself not so long ago, Swisher went public in late 2010 with grand plans to consolidate firms that provide cleaning services into a single empire under the seasoned guidance of the same executives who built the Blockbuster and Waste Management (NYSE: WM) chains. Thanks to the breathless pace of its top-line growth and the high-profile status of its leaders, Swisher soon took off as a powerful momentum stock – its market value ballooning past $1.5 billion at its peak -- but deflated for good once TheStreetSweepersounded an alarm about the company.

Regardless of its expertise at cleaning bathrooms and such, the company itself turned out to be a real mess. A repackaged failure with its original stock trashed by its namesake founder on his way to prison for fraud, Swisher looked even worse than some rollup companies that might have fuzzy numbers and red ink all over their books. With its dark secrets exposed, Swisher took an ugly hit and – now in the process of scrubbing its financial statements – could soon lose the stock listing that it secured less than two years ago. A double-digit stock at the height of its craze, Swisher has already plunged to just $1.66 a share in the meantime.

These days, the same rollup company that made such a big splash with its sharp gains is instead making embarrassing news for its stupidity by landing in a popular weekly column known as “The 5 Dumbest Things on Wall Street.”

During its past two quarterlyconference calls, for example, Tangoe merely offered a vague “estimate” that placed its organic growth rate “in the low to mid-20% range” and (as usual) above the targets set by the company itself. While this estimate may look both solid and consistent, the possibilities implied by that range all fall below the figure supplied a year ago and therefore represent a slowdown in organic growth. Without the precise formula (and underlying numbers) that Tangoe uses to calculate its organic growth rate, however, investors cannot monitor – or independently verify – this reassuring metric on their own.

Without any helpful surge from acquisitions, those estimates indicate, Tangoe would have seen its core revenue grow by just 13% -- a full ten percentage points below the midpoint of the range presentedby management – throughout the first half of the current year. Furthermore, earlier pro forma numbers suggest, Tangoe would have mustered only single-digit revenue gains on its own the year when the company arrived on the market in the midst of a tantalizing growth spurt.

Without rushing into that deal, recordsindicate, Tangoe would have been stuck with a forecast that Wall Street (accustomed to better) might view with alarm. Excluding the projected cushion provided by that deal, Tangoe would have issued guidance that actually fell a bit shy of its previous top-line estimates for the second-half of the year and (when adjusted to reflect a change in the share count) simply matched its prior bottom-line forecasts at best.

While Tangoe may have raised its guidance by a healthy margin as a result of that deal, however, outright bulls raised some ratherpressing questions in response. Now that Tangoe has purchased so many of its smaller rivals, one analyst wondered, was the company finally ready to “take a breather on some of the M&A (merger and acquisition) activity for a while?” If not, the analyst asked, would Tangoe be returning to the capital markets with its hands out once again?

Tangoe must cough up $34.4 million to cover leftover acquisition payments and operating leases over the course of the next 12 months, its filings show, with the bulk of that eaten up by the hefty sums that it still owes on companies already stuffed into its bulging portfolio. Beyond that, Tangoe has also listed “amounts due under various debt and credit facilities of $17.6 million” in its most recent quarterly report. With all but $14 million of its existing funds already committed for acquisition and lease payments, its filings indicate, Tangoe lacks even the cash necessary to offset those existing liabilities.

At the same time, of course, Tangoe must cover routine expenses – with the company spending $2.4 million so far this year on rent payments alone – and obviously save some cash to finance its actual operations. Since Tangoe needs so much money to cover its bills and generates only so much cash on its own (while barely clearing $500,000 in actual profits in the first half of this year), records indicate, the company looks strapped even without the added burden of yet another expensive shopping trip.

Regardless of its financial situation (and the gentle suggestion of a friendly analyst), however, Tangoe has so far refused to back away from its capital-intensive growth strategy. When directly pressed on that sensitive matter upon closing its new record-breaking deal, in fact, Tango bluntly stated that it would “continue to look at acquisitions” and strongly implied that it had plenty of cash to spare.

Curtain Call?

At this point, however, Tangoe could find itself hunting for attractive targets in vain. After all, logic would suggest, Tangoe cannot keep on acquiring other players in the same space (and booking their revenue as its own) if it has run out of companies to buy.

“With the closing of this acquisition,” Barclays quickly noticed, “Tangoe has really completed the majority of the possible consolidation in the TEM market, as they are significantly larger than the next closest competitor” and significantly smaller than a pair of heavyweights that round out the group.

If anything, recordssuggest, Tangoe better hope that IBM simply keeps on sending a lot of business its way.

Tangoe landed IBM as a major client back in the fall of 2009, when the two companies forged a “strategic relationship” that offered benefits to both parties involved. After that, Tangoe counted on IBM for more than 10% of the revenue that it reported for two years in a row. Tangoe in turn rewarded its big partner for the business that it provided, filings show, issuing IBM warrants for a huge pile of its stock in exchange for meeting established revenue targets.

Before IBM swallowed a Tangoe rival of its own during the first quarter of this year, recordsshow, it scored plenty of those warrants and exercised them at prices that offered some rather handsome paper gains. By the end of the very next quarter, however, that situation had apparently changed. Since its big partner failed to meet “specified new contractual revenue commitments” under a revised agreement set forth last year, Tangoe revealed in its recent quarterly filings, IBM earned no additional warrants and that agreement effectively expired.

When questioned about IBM three months earlier (more than nine months into that amended 12-month agreement), however, Tangoe had reassured investors about the status of that important relationship. Subbloie had specifically characterized the situation as “status quo” during the first-quarter conference call, adding that company leaders “don’t see any change in the relationship” with IBM and “still feel good about the channel partnership” that the company had established.

To some Tangoe skeptics, however, that arrangement looked shaky at best -- and hopeless at worst – even then.

“The question had been, ‘When your strategic partner acquires a big competitor, does it hurt your sales?’” recalled a hedge fund manager with a short position in the stock. “The answer seems to be, ‘Yes.’

“This seemed like a ‘pay-to-play’ deal in the first place,” the bear added, “given that IBM seems to have gotten paid in Tangoe warrants/shares a significant dollar amount relative to the sales they generated for Tangoe. Now IBM has no remaining incentive to do business with Tangoe. Plus, they own a Tangoe competitor.

* Important Disclosure: Through its members, TheStreetSweeper established a financial position in TNGO prior to the publication of this report and will profit on future declines in the share price. At the current time, TheStreetSweeper has sold a total of 123,773 shares of TNGO short at an average price of $20.65 a share. Going forward, TheStreetSweeper may choose to adjust the size of its TNGO investment -- by increasing, decreasing or covering its short position in the stock -- and will fully disclose the details of any future transactions as those trades occur.

* Update: Since the release of its investigative report on Tangoe, TheStreetSweeper has closed out its short position in the stock by executing the following transactions: covering 43,171 shares on Aug. 28 at an average price of $17.26 a share; covering 44,100 shares on Aug. 29 at an average price of $17.03; covering 11,000 shares on Aug. 30 at an average price of $16.62 a share; covering 3,000 shares on Aug. 30 at an average price of $16.20 a share; covering 1,900 shares on Sept. 4 at an average price of $16.73 a share; covering 2,102 shares on Sept. 5 at $16.84 a share; and covering the final 18,500 shares on Sept. 6 at $15.51 a share. As a result, TheStreetSweeper has no financial position in TNGO at the present time.Going forward, however, TheStreetSweeper may choose to establish a new short position in the stock. If so, it will fully disclose the details of any future transactions in the stock as those trades occur.

As a matter of policy, TheStreetSweeper prohibits members of its editorial team from taking financial positions in any of the companies that they cover. To contact Melissa Davis, the editor of this website and the author of this story, please send an email to editor@thestreetsweeper.org.